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ite selectors throughout North America will long recall 2001 as the year energy cost and availability moved to the top of their location criteria lists. Not long ago, it was virtually taken for granted that affordable and abundant electricity was within reach of any new project location that made the short list. Property asset managers now must be familiar with new elements on the energy landscape, particularly alternative energy sources and technologies that can lessen their organizations’ dependence on an increasingly frayed national grid.
Huge savings in operating costs may also result from putting in place a portfolio-wide energy strategy that supports corporate goals and objectives. A new perspective, certainly fresh thinking, is necessary to make this happen. Site Selection Magazine convened a luncheon roundtable meeting of experts on these topics at the offices of Ernst & Young (E&Y), in New York City, this past June to glean from them some new perspectives that corporate property managers may want to apply in their organizations. Participating in the discussion were Carl Marano, national director of E&Y’s Energy Advisory Services practice, in Phoenix; James Glennon, director of E&Y’s Real Estate Advisory Services practice; Paul Slye, president of RealEnergy, a Los Angeles-based developer of onsite power generation systems; Trevor Foster, vice president, development, at Norwalk, Conn.-based EMCOR Facilities Services; and Richard Greene, director of international projects at ZeTek Power Corp., New York, a manufacturer of fuel cell technology. Mark Arend, Managing Editor of Site Selection, moderated the discussion.
Site Selection: How concerned are your clients about energy costs and supplies? Are they in crisis mode yet, and should they be?
James Glennon (E&Y): I wouldn’t say our site selection clients are in crisis mode right now. Our clients look for red flags, and California is waving one. Reliability of supply and its cost being of a certain fixed nature over time are two things they have always expected and still expect. Some clients feel they don’t want to go there right now, and if that happens in other states it will raise the same red flag. Naturally, it’s a much bigger issue for the manufacturers.
Carl Marano (E&Y): It will depend on what part of the country you’re in. Clients are more keenly aware of energy as being a significant cost with respect to their whole operation. New York and California, of course, are the two hot places in the country right now where the issues are really paramount on property owners lists. Those in other parts of the country are also keenly aware of energy costs as a result of what’s happening in the news, especially those with large portfolios of property throughout the country.
Paul Slye (RealEnergy): Our clients today are principally owners and operators of commercial real estate. However, their clients are the corporations that operate businesses with mission-critical services from those locations. Many of those are fiduciaries and are bound by law and other forces to meet the needs that present themselves through energy risk, which is huge and which is making it nearly impossible for people to plan constructively what their year is going to look like. There is volatility not only on the supply and reliability side, but also in terms of pricing, and that is disrupting a lot of peoples’ plans and affecting their location decisions. That community is trying to educate and galvanize itself so that they are partners in managing the risk and trying to then get the additional opportunities presented by value-added services, be it reliability or power quality, that will result. It’s an exciting time, but one fraught with a lot of disruptions. But at the same time a lot of new technologies are coming online, which pose a responsibility to vet and implement and integrate those so that they serve the tenant.
Richard Greene (ZeTek Power): These are interesting times. Companies are going to have to make decisions based on the current landscape of electrical supply and cost. Even internationally, they’ve been dealing with some of these issues that the United States hasn’t had to deal with in 50 years or so. In the medium term, say five to 10 years out, the new technologies will emerge on the marketplace — micro-turbines, fuel cells, and so forth — that can allow a company to have electrical independence, meaning that they bring with them their main unit for electrical consumption and demand. Suddenly, there may be a great deal of independence out there for where a company might site based on the fact this is no longer a consideration; it’s a standard cost that they bring with them.
Trevor Foster (EMCOR): We operate facilities all over the world, and there’s a fundamental shift going on from a cost point of view in terms of how you run a facility. It’s no longer where energy is a cost which is a fait accomplit. We’re finding clients asking us, as we look at portfolios, to look at energy across their entire portfolio and how do you manage the energy on that level rather than on a location basis? Historically, your energy costs were based on the bounds of your building. You had supply into the building, a stable, fixed prices, demand was manageable, but the cost was within the building. Now, you as a company have a huge energy bill, and depending on how you manage that portfolio in real time both on the demand and the supply side, there are controllable cost issues you deal with and some significant opportunities for whether you generate on your own if you respond to the market in real time. The large corporations are saying they not only want o look at where they locate the site, but how do they manage energy across their portfolio as a controllable cost, and how do they take advantage of the fact that they have all this energy load and how do they get the best leverage across the whole marketplace. Clients want a strategy to do all of this, not just the location part. That’s occurring for two reasons. One is deregulation around the world, particularly in England and the U.S., and the second is the emergence of information technology to allow this to take place in a real-time mode. It’s changing how people run facilities and how they factor energy into the cost of running a business.
Marano: That’s right. Most of the clients we deal with don’t have the expertise to really address the key issues of how to develop that strategy, what is best for them, what products will best help them manage their overall costs, and so forth. Should they look a new contracts in the deregulated states? How can they do that to best reduce their bottom-line cost? And how does that mesh with their operating or demand side so they can get the best costs overall? That’s really what clients are looking for –guidance as to how to get through that set of issues.
Foster: In California right now, a big question is, What is the right temperature to run your building? And most would say 72 degrees. Well, if the energy were five times more expensive, would you be willing let your business run at 78 degrees? The decision is coming in now that there is a cost-benefit relationship in how you run your business vs. how you run your energy. We’re deploying a program now California that analyzes the effect of raising the temperature in a building by a certain amount. This will make people more uncomfortable, but it’s a response to a business need. If you can’t afford to run the business at 72 degrees based on energy pricing, you may have to plan to be a bit more uncomfortable, or it becomes a business issue. This link between energy and business hasn’t really been there in the past, other than as a cost issue. Now, it’s a cost-benefit issue in how you run the business.
Slye: It’s driving a whole new menu of services as well as technologies. You’re combining curtailment, which is reducing load onsite and creating different ambient conditions, finding out what the tolerances for those are, but also it would include in many cases abrogation, commodity-purchasing arrangements that can bring in a lower price for pieces and parts of your load. It includes in some cases conservation and generation on site, so there’s a whole new constellation of elements that’s as diverse as the players. The utilities that in many cases can’t or don’t have the capital or interest in responding to those needs are being challenged by new players, and certainly by their clients — the corporate users — to come up with new solutions.
Greene: To illustrate how energy can change a company’s business strategy, there are several aluminum producers on the Columbia River that are there because they use power from the various dams there. And they have long-term contracts for that power. They are now shutting down their activities — they’re no longer producing aluminum. But they’re selling and making their profit, which is quite considerable, on the demand that is coming from California and other areas for their electricity. There’s more profit to be made in selling their electricity.
Foster: It’s that link between the energy and the business strategy. You develop the energy plan, and it’s not only a cost, but a revenue producer — something you can do that makes your company more profitable by how you deal with your energy strategy.
Marano: That’s an important point. In addition to that, the fallout from all of this will impact the nation. Long-term, if the aluminum plants shut down, and the heavy concentration of aluminum production is in the northwest, eventually that will affect the price of aluminum throughout the country. When those plants finally do come back online, there will be a shortage of aluminum, and people all over will feel the impact of the energy crisis in the West.
Site Selection: So it is incumbent upon corporations to have in place a strategy for taking advantage of revenue opportunities where energy usage is concerned.
Foster: Yes. We’re seeing a rush of people seeking to put in place an energy strategy, particularly the more sophisticated clients.
Slye: Carl [Marano] makes a great point, which is that there will be dislocation in the supply chain of critical elements for production, and labor — in many cases companies shutting down for the month of July. That used to happen because of a strike, and now it’s part of a strategy for improving the bottom line. This is an infrastructure issue that the entire nation faces and that will affect every major metropolitan area more immediately. But certainly as we grow and see the changes in the national grid structure, this has to be addressed, and there are folks that the community at large is going to look to. [Users of energy] don’t want a rate break or price signals in California, so they accrue. Now everyone’s waiting for the next show to drop. Will it be a bond assessment or a tax increase? These things affect the strategies people implement and the decisions they make to locate and operate facilities. I would commend in some respects the policymakers in Washington who are grappling with a national program that will address the generation issues, bring new technologies to the fore and address the issues of distribution and transmission. Because that is something that all of your readers will face in the near future.
Site Selection: Are energy strategy models or templates emerging to which asset managers can turn as they formulate their strategy?
Marano: The strategy would be specific to each company and its goals and objectives. What makes sense for one company wouldn’t necessarily make sense for another. You’d have to look at where they’re located, the kind of business they are in, how they operate, whether on-site generation would work for them and other factors. It’s a complex issue.
Slye: And the unit costs per industry change. In the case of insurance and real estate industry operations — call centers, for instance — the unit costs for down time, the lost data, the cost to equipment, the employees sitting on their hands, differ from region to region, industry to industry.
Marano: Clients tell us they don’t understand how they’re using energy today, and they want to get their arms around that and determine what the best strategy is for them.
Foster: That’s right. Clients we deal with vary in their level of sophistication. Looking at the marketplace, you can usually divide the types of energy groups or strategies into four categories. One is the traditional demand management — use less energy and use it more efficiently. Then there’s supply management, which is buying energy from the right source at the right rate at the right time. Those are the traditional methods. Then you move into more active energy management, where you’re monitoring the energy usage in some sort of batch process to deliver information through the system to be able to do demand and supply management better. That’s appearing all over the place now. The fourth group is when you get into intelligent energy strategies, where you’re taking the active monitoring of demand and supply and you take your business system into this intelligent energy approach and make decisions about what to do with energy in terms of your real business objectives. That gets into expert systems, neural network approaches and algorithms to deal with that. That’s starting to appear. Some people are moving in that direction, because technology is allowing it to happen.
Glennon: Most of the clients I deal with are office users and are subject to what happens in the electrical supply industry. The landlords and how they apply that electricity will determine their costs. They’re not able to make active decisions. They need to be in operation certain hours of the day. To the extent that the landlord attempting to do something with the electricity to hold down demand at certain times of the day impacts the way they conduct their business, it will have a negative impact on the area in terms of its ability to attract industry. That will be a big problem, certainly in California and perhaps elsewhere.
Foster: Do you think lease structures are starting to change because of the energy problems?
Marano: Absolutely. Lease structures are a primary concern now. In most cases, the kinds of leases clients have vary. The landlords and owners are trying to determine if they’re recovering all of their energy costs through their lease structures with the tenants. In most cases, they’re finding out that they’re not.
Slye: And as the landlord’s relationship with the utility is redefined, that changes by default the nature of the lease obligations they can make – what service is provided, what is constructive eviction? Perhaps rhetorical questions, but the bottom line is that owners are taking corrective steps, which affect the community at large to manage the load, to do so with not only their leasehold obligations, which are legally binding, but their obligations to equity holders, to debt holders and others. That’s something that is going to happen rapidly, because these are fiduciary interests, and these folks take very seriously the fact that to replace a tenant relationship is many times more expensive in real estate than in any other business that I know of. When you have vacancy downtime, tenant improvements, debt and equity payments that don’t stand still whether or not the building is vacant, all of which combined are very compelling. And the landlords will manage these different strategies very aggressively and to the benefit of their tenants ultimately, or the ones I should say who choose to focus on whether they need added services or whether they simply care about reliability. But it will have an effect on the leasehold relationship.
Greene: They have to be very aggressive right now, because the opportunity for companies to move out of these big red flag problem areas are very great. Has anyone seen evidence of companies fleeing from the trouble spots?
Glennon: Lease are five, 10, 15 years, so that’s not something that will happen. The problem will be with the landlord who has the right to at least pass through increases in electrical power. Then the tenant gets his operating expense statement and the public cost of power has gone up 50 percent. So if, when his lease expires, that condition is still in effect, he’s going to look for other opportunities, if in fact they exist.
Slye: Landlords are differentiating themselves, because they have to. I’m seeing the regional effect, such as someone operating an office building in Southern California Edison territory vs. Los Angeles, and you might have someone who is marketing against them relative to their supply of power. If a big call center or office user is thinking about relocating within an area, they do look at that. So it can be more localized or inter-regional decision-making. Plus, the capital markets are watching these companies. Some public companies are getting credit — appropriately — in the public markets for their aggressive management of onsite consumption through conservation measures and the investment and the return of that. The marquis value they earn with tenants is significant, because they’re doing both the environmentally responsible thing and the operationally responsible thing. And they’re looking though our efforts at onsite power generation, which again is going to be part of an entire program to manage the energy puzzle.
Marano: From a site selection standpoint, energy price is becoming an issue. But moreso, in the immediate timeframe we’re talking about, clients with mission-critical businesses are more concerned about system reliability and capacity. Will there be enough capacity to sustain the growth of the business in the location they are currently in? That’s where onsite generation is a key issue, if there is some way they can get some control of that and better manage their overall business and reliability.
Site Selection: Let’s talk about some of the alternative energy technologies of interest to real estate managers. Richard – what’s happening on the fuel cell front?
Greene: Fuel cells are an electro-chemical engine that can bring a power source to any particular point of need. What’s really exciting about this for a facility management or large industrial application is that these fuel cells can be brought to the point of usage often independent of the grid and managed separately. The facility manager has control over energy usage. We have an agreement with a series of co-ops in the south that face EPA pressures to ensure that they do not increase their energy generation such that they will trigger additional environmental problems but still need to fulfill the demand that the companies in the co-op have. So we’re working on pods of 250 kilowatts of generation and putting them in a distributed generation system whereby we can produce megawatts of power for an industrial facility, residences and buildings. An office building can have in place fuel cells or some other alternative technology on various floors, making it independent of the grid. We see this happening in the not too distant future, meaning within about 18 months.
Slye: This technology provides the end user with an opportunity to harvest not one but several products. You can take the kilowatts off these devices and use them constructively; you can do co-generation and tri-generation. You can scale it and use energy efficiently. The fuel cell over time will prove to be an excellent source of power at the point of consumption, and it’s very clean, which will become increasingly important.
Site Selection: What needs to happen for there to be broader acceptance of alternative energy technologies?
Foster: In the UK there is legislation in the works involving environmental credits. They are forcing industry to be more environmentally attuned, and they will be lowering companies’ social security tax contributions in line with that. Use of a fuel cell or some other technology will result in a credit in their tax base.
Slye: Monetizing environmentally sensitive behavior has a huge leveling effect on the playing field. Historically, traditional sources of fuel — coal, oil and diesel — have had a built-in advantage in some respects, because the collateral cost of using those fuel sources gets passed through in other ways. What’s happening in Europe and other places is that they are trying to monetize and incent business to make constructive decisions so the entire community benefits. It’s good news for people who care about the environment and for those who want to create a feeling of social goodwill among employees and in the community.
Marano: The bottom line is there has to be some incentive for people to make a change, and this is a drastic change from the norm. The incentive can be in the form of government incentives or credits or rebates or rate incentives. But there has to be something like this in place to effect change.
Greene: A number of bills are before Congress right now that are addressing where credits might fit into a process of incenting the up-front development costs of the new technologies.
Marano: That’s the issue — they are not cost-effective at this point unless you factor in the incentives. Fuel cells are a great technology, but they’re in the development stage now, so it’s difficult to really justify putting one unless there’s some particular cost factor at work.
Site Selection: What other new energy technologies should the corporate real estate community be looking into?
Slye: Our suite will be comprised of gas internal combustion engines that are a proven and reliable technology. It beats the local air quality requirements, it’s low vibration, low noise, and it’s compact. It integrates well with existing infrastructure. We’re also working with micro-turbines, but when we try to do co-generation, it’s a challenge but one the manufacturers are addressing. It’s a very efficient and reliable technology with low operations and maintenance. Having said that, the pedigree of these devices is still relatively new. The same is true of fuel cells. Initial cost is a huge issue and a huge challenge. For us to include these things in our fleet, which we’re doing with the help of air quality districts, we have to harvest subsidies. We haven’t gotten to a point yet in our customer base where are people are willing to pay a premium price for the power. That’s coming online very quickly, however, and that means great things for the manufacturers.
Marano: The technology exists today, but it’s really only cost effective where the price of energy is higher. You need to look at the total life cycle of the installation to make sure it’s cost-effective. The more you suppress the price of energy and don’t let the market conditions really come into play, the less apt you are to see some of these other technologies come into the marketplace.
Foster: Whatever happens with technology, there will be an exponentially growing need for power. The supply side will grow because of that, but the need for electricity, the demand will drive the price.
Marano: What most people don’t realize is that you can’t build a power plant in a day. It takes years before you have any relief in new power generation. There are lots of issues as to why we are where we are, with an aging transmission system and an old fleet of generating plants. We need to do something quickly to get the ball rolling. We’ve talked about some stop-gap measures we can take and some possibly long-term solutions as we go forward. The demand for energy will be less the more people start investing in those types of technologies and gain some control over their energy use, which will bring about less demand on the grid system.
Site Selection: How will the role of utilities change given this scenario?
Slye: They have a lot of power to obstruct our progress in providing our service to our clients At the same time, they can and do in some cases make excellent partners. They usually have a low cost of capital, they have corporate knowledge and expertise, and they have a lot of motivation to retain a customer relationship that is under stress. For that reason, they are facing the same issues we do as consumers, and they hopefully will be creative in working with new partners to provide new products and services. If they wan to continue to exist and control the markets they do, it will take recognition of the fact that they need to change their menu of offerings and way they work with the regulatory system and try to help foster change rather than block it.
Greene: It’s interesting that as a fuel cell company we can be seen by utilities as a disruptive technology coming in to take over their turf. But where we have been siting plants and working with utilities for demonstration projects, we are seeing a god deal of embracement of the technology as a way to solve problems and to offer their market a choice or an opportunity.
Marano: Many utilities are very proactive and have planned for deregulation and as a result are doing very well. They’ve reduced their rates and streamlined their operations and take it very seriously. Those are the utilities that will survive. As more plants come online throughout the country, and they feel the pressure of more competition in a deregulated environment, they will have to change. If they don’t, they will not survive.
